Tuesday, April 26, 2005

April hasn’t been the kindest month for the U.S. economy. Weak employment and retail sales reports, along with rising inflation, have raised the specter of weaker than expected growth. Some disappointing earnings news from the likes of IBM, GM and Ford hasn’t helped either.

As a result, the S&P 500 has dropped 1.6% so far this month and 10 year T-bond yields are nearly 30 basis points lower than at the end of March.

Interestingly enough, the commodity markets have been mostly unfazed. This is unusual, since commodity prices have boomed recently: the IMF’s commodity price index posted a 33% jump over the 12-month period ending this march. According to most analysts, strong demand, driven in turn by high economic growth in the U.S., China and other developing nations, explains why commodity prices have risen so much.

One would think that if U.S. growth were to unexpectedly slow, commodity prices would post steep declines. Yet, oil prices are nearly at the same level seen at the end of march. At the same time, metals prices at the LME have also stayed mostly unchanged or have posted small declines.

Given the rise in stock prices over the last few days, it seems the commodity markets were right all along, although long term interest rates haven't risen. That is, unless the scariest scenario comes to pass: commodity prices stay high despite falling economic growth (aka the stagflation scenario). It's possible, but very unlikely.

Which is a better leading indicator? Personally, I put the most store in interest rates, but the answer is open to debate.